Sunday, February 15, 2009

Deep value plays

As S&P 500 earnings have started their collapse (see articles here and here), there has been a debate about whether this market constitutes good value. From a bottom up basis, however, I am seeing values that I haven’t seen in a long time.

Screening on net-net working capital
Using the free data from the Yahoo! finance website, I wrote a program that screened an investment universe that is roughly equivalent to the Russell 3000 members. The test is: stocks that trade below net-net working capital (current assets less all liabilities and preferred) and has positive trailing 12 month earnings. The net-net working capital requirement is a classic Ben Graham deep value criteria. The earnings test represents an additional margin of safety of corporate viability.

I got 39 names. Even if I threw out the microcaps (market cap below $100 million), I still got 13 stocks that passed the test:

Adaptec Inc (ADPT), Cynosure Inc (CYNO), Fuqi International Inc (FUQI), Horsehead Holding Corp (ZINC), Ingram Micro Inc (IM), Movado Group Inc (MOV), Olympic Steel Inc (ZEUS), PC Connection Inc (PCCC), Shoe Carnival Inc (SCVL), Skechers U.S.A. Inc (SKX), Tech Data Corp (TECD), Tecumseh Products Co (TECUA) and Volt Information Sciences Inc (VOL).

Stocks trading below net cash
Using the more restrictive criteria of non-financial stocks trading below net cash (cash less short and long term debt) and that are earnings positive, I got three names:

Adaptec Inc (ADPT), AuthenTec Inc (AUTH) and Cutera Inc (CUTR).
Two of the three trading below net cash are Technology stocks. This is confirmed by a recent story stating that many Tech companies are sitting on large cash hordes.

On a slightly unrelated note, a recent paper by Dino Palazzo shows that shares of companies with large amounts of cash exhibited higher returns.

Value in this market
I would disagree with those who say that there isn’t value in this market. There are good fundamental values to be found for investors who are willing to dig around and these screens support my contention that the downside risk to this market is limited.

Disclaimer: The caveat to these lists is that they represent a starting point for further research and you should not blindly go out and buy them without further investigation.

1 comment:

skarab said...

I would counter that you should only buy those names against being short their equal dollar amount in the S&P500 or their specific sector ETF.

From WSJ: With the help of the Center for Research in Security Prices, or CRSP, at the University of Chicago's Booth School of Business, I sought to answer this question: If you had invested on Jan. 1, 1930, after the crash already had destroyed a third of the stock market's value, where would you have gotten the greatest gains?

The short answer: In 1930, 1931 and 1932, nowhere. There was no real refuge in the storm; even Benjamin Graham, the great value investor, lost 60% over those three years.

However, I believe that you can find idiosyncratic risk that will create alpha for you but you need to neutralize the beta in this specific environment.